Key Futures Terminology — Spot, Basis, Contango, Backwardation
Spot price is the current cash-market price of the underlying. Futures price is the traded price of the derivative. Basis = Spot − Futures. When Futures > Spot ...
Pricing Language of Futures
Spot price is the current cash-market price of the underlying. Futures price is the traded price of the derivative. Basis = Spot − Futures. When Futures > Spot the market is in contango; when Spot > Futures it is in backwardation. Basis converges to zero on expiry day.
Contango is the normal state — futures trade above spot because the carrying cost of holding the underlying (interest on money borrowed to buy, minus any dividends received) pushes futures above spot. Backwardation is rarer and typically signals near-term supply tightness or high expected dividends. Basis is positive in backwardation, negative in contango (NISM defines basis = spot − futures, so contango gives negative basis; many market practitioners use the reverse sign — read the question carefully). Regardless of sign convention, basis must converge to zero on expiry — which is how cash-futures arbitrage works.
Futures trade above spot — carrying cost of holding
Spot > Futures — typically near-term scarcity
By expiry, spot = futures (basis = 0)
Trading two expiries of the same underlying — betting on basis change
A Practical Example
Nifty spot 22,500. Nifty May futures 22,600 (contango — positive carrying cost). Nifty Jun futures 22,660. Nifty Jul futures 22,720. The upward curve is the "cost of carry" — roughly (22,720 − 22,500) / 22,500 ≈ 1% per two months ≈ 6% annualised, in line with the short-term risk-free rate. If a corporate dividend event is announced, near-month futures may drop below spot temporarily — that is mini-backwardation in the dividend month.
What Makes This Important
Basis and Carrying Cost
Basis = Spot Price − Futures Price Carrying Cost ≈ Futures − Spot (for equity index with no dividends)
Frequently Asked Questions
On expiry day the futures settlement price is set equal to the spot closing price. If basis were non-zero near expiry, arbitrageurs would trade the gap by buying the cheaper and selling the dearer — forcing prices together.
🧠 Quick Quiz
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